It also plans to rehire the 4,000 workers it had already transferred to IBM

IBM lost one of its highest-profile outsourced IT clients today, as JPMorgan Chase & Co. announced that it is canceling the remaining portion of a contract that was intended as a seven-year, $5 billion deal.

New York-based JPMorgan said its July merger with Bank One Corp. led it to reconsider its IT strategy. The new firm has significantly greater capacity to manage its own technology infrastructure and decided to bring its IT support staff back in-house, JPMorgan said in a statement.

JPMorgan and IBM will wind down their existing contract this year, and in January 4,000 employees and contractors that transferred to IBM when the deal was made in December 2002 will begin transferring back, JPMorgan said.

The original contract called for IBM to take over significant IT functions for JPMorgan, including managing its data centers, help desks, distributed computing, data and voice networks. JPMorgan planned to retain some functions including application development and delivery and desktop support.

IBM spokesman James Sciales said IBM will still provide hardware, software and services to several JPMorgan units, including retail banking, treasury and security services and investment banking. He also said IBM doesn't expect the canceled contract to significantly affect its head count, as it proceeds with plans to hire 18,000 new employees this year to reach its highest staffing levels since 1991. Many of those new hires are expected to come from countries with lower-cost, developing labor markets, while one-third of the new staff will be added in the U.S.

IBM said it had still been investing in building resources for the JPMorgan contract and doesn't expect the cancellation to negatively affect its financial results for the year. Sciales declined to comment on whether IBM will receive a termination fee.

When IBM announced the JPMorgan win nearly two years ago, it hailed the deal as a groundbreaking one that would illustrate its newly unveiled "on-demand" strategy for adding flexibility to corporate IT infrastructures. ZapThink LLC analyst Ronald Schmelzer predicted at the time the deal would be IBM's "poster child for on-demand."

"Poster children have pluses and minuses," Schmelzer said today about the cancellation. "Whether it will be seen as a knock on IBM's reputation depends on the reasons for the cancellation."

If changing needs after its merger were really the key reason JPMorgan exited the contract, then IBM is likely to escape any blame, Schmelzer said. But if other visible clients choose to end their multibillion-dollar outsourcing deals early, IBM may need to adjust its strategy.

"There are a lot of companies that do big outsourcing deals, but IBM is really in a league of its own. The whole on-demand computing plan is unique to them," Schmelzer said. "Whether or not it's a long-term success depends on their ability to execute and demonstrate returns for their customers."

Two other large IBM outsourcing customers said they're happy with their arrangements and don't anticipate changes. Representatives at Qwest Communications International Inc., which last year signed a long-term deal that analysts valued at up to $2 billion, and at American Express Co., which has a $4 billion deal, said their contracts are progressing as planned.

"We're two years in, and we're meeting our objectives," said American Express spokeswoman Judy Tenzer. American Express signed a seven-year contract with IBM in early 2002.

Analyst Bill Bradway at research firm Financial Insights said the changing-needs explanation for the cancellation is believable in this case. Bank One brought to JPMorgan a much larger retail banking presence, and Bank One CIO Austin Adams, now CIO of the merged company, is known for his "do-it-yourself" ethos, he said.

Bradway doesn't expect the canceled contract to spark a rip-and-replace effort at JPMorgan.

"At the end of the day what's happening is that 4,000 people will turn in their IBM badges and get JPMorgan ones," he said. "Many of the systems they're working on will continue to be the same ones."